5 dividend stocks that may be safer than Treasurys

Are you surprised U.S. Treasury bonds have outperformed stocks this year?

The Bloomberg U.S. Treasury Bond Index returned 3.2% through the end of last week, beating the S&P 500 Index’s 2% gain as investors have lost their nerves with equities pushing up against record highs.

It’s been a topsy-turvy market, for sure. The yield on 10-year U.S. Treasury bonds rose to about 3% at the end of 2013 from 1.78% a year earlier, with selling pressure increasing as investors anticipated the Federal Reserve’s decision in December to begin reducing its purchases of bonds. But investors have poured money into Treasurys this year, sending the yield on the 10-year bond down to 2.52% on Friday. And companies around the world have raised a record $368 billion this year from bonds maturing in 10 years or more, Bloomberg News reports.

The Fed’s bond buying and its policy of keeping the federal funds rate close to zero since late 2008 has boosted the money supply at a rate far exceeding that of gross domestic product growth. According to the central bank’s figures, M2 — the sum of money held by the public in transaction accounts, money market accounts and retail money market funds, as well as time deposits with balances of less than $100,000 — increased 2% in the first four months of this year.

During 2013, M2 swelled 5.4%, while the estimated GDP growth rate was 1.9%. In 2012, it was 8.3% and 2.8% — this pattern has gone on for years. The bottom line is that the money has to go somewhere, which helps explain the stock market’s explosion over the past two years, and Treasurys’ rebound this year.

The Federal Reserve expects to wind down its bond purchases this year, and could decide in 2015 to begin raising the federal funds rate.

At some point soon, at least, the money spigot will be turned off. That will mean downward pressure on bond prices and possibly some pain for stock investors as well. This prediction has been made for the past several years, and this year’s action has shown just how premature many investors were last year in expecting a radically changed interest-rate environment.

Investors seeking current income may well be better off building positions in quality companies paying high dividends on common shares.

Warren Buffett has recently done just that. His Berkshire Hathaway Inc.
BRK.B, -0.36%
in a 13F filing disclosed that during the first quarter it built up a new position in Verizon Communications Inc.VZ, -0.78%
shares. Berkshire held 11,022,743 Verizon shares worth $524 million. Verizon pays out 53 cents per share each quarter, for a yield of 4.42%, based on Thursday’s closing price of $47.96. So Berkshire’s annual dividend on its Verizon stake comes to a tidy sum of $23.4 million.

To develop a list of buoyant dividend stocks that might be better choices for income and safety over the next few years, we pared the S&P 500
SPX, +0.01%
to the five stocks with the highest dividend yields that also meet two other quality standards. All have shown growth in annual sales per share over the past two years and produced sufficient free cash flow during 2013 to more than cover dividends, according to data provided by FactSet.

Here’s the list:

Interestingly, three telecommunications firms made the list, as well as the leading U.S. cigarette manufacturer and a regional bank. Here’s more information on all five:

CenturyLink

CenturyLink Inc.
CTL, +0.10%
is a telecom-services provider headquartered in Monroe, La., that operates land lines in 37 states. CenturyLink also offers broadband Internet services, runs 55 data centers in North America, Europe and Asia, and also provides various data, cloud and hosting services to corporate clients.

CenturyLink’s stock closed at $37.82 Thursday, returning 21% this year, following a 13% decline during 2013. Those figures compare with 2% and 33%, respectively, for the S&P 500. CenturyLink pays a quarterly dividend of 54 cents, for a yield of 5.71%, the highest on the list. The company’s free cash flow last year totaled $4.18 a share, showing it covered the dividend comfortably.

For the first quarter, CenturyLink reported net income of $203 million, or 35 cents a share, down from $298 million, or 48 cents, a year earlier. Adjusted core revenue was “nearly flat” at $4.11, which was an improvement from a 2% decline a year earlier. The company also reported solid growth of 66,000 high-speed Internet customers and 24,000 customers for its Prism TV service. That helped mitigate the continued decline in revenue from legacy (land line and long distance) services, which was down 6% to $1.83 billion.

Meanwhile, the company reported a 5.4% increase in adjusted strategic segment revenue (which includes broadband service) to $2.16 billion, and a 24% rise in data integration revenue to $174 million.

Investors’ enthusiasm this year reflects confidence in the company’s ability to continue throwing off sufficient cash to support the dividend, while navigating the continued transition from land-line services.

AT&T

AT&T Inc.
T, -1.02%
is next, with a dividend yield of 5.04%, based on a quarterly payout of 46 cents and Thursday’s closing price of $36.52. The stock has returned 7% this year, following a 10% gain in 2013. The shares trade for 12.9 times the consensus 2015 earnings estimate of $2.84 among analysts polled by FactSet. That’s the second-lowest forward price-to-earnings ratio among the five dividend stocks listed here.

“Given the structure of this transaction, which includes AT&T stock consideration as part of the deal and the monetization of none-core assets, AT&T expects to continue to maintain the strongest balance sheet in the industry following the transaction close,” the companies said in a joint press release.

AT&T will pay about $48.5 billion for DirecTV, and the purchase will be made with roughly 30% cash and 70% stock. Factoring in DirecTV’s debt, the total value of the deal is $67.1 billion. The issuance of new shares means a significantly higher dividend payout for AT&T, but the combination will also increase free cash flow per share by 7% to 10%, and lower the company’s ratio of dividends paid to earnings per share to about 79% from a range of 84% to 88%, according to an estimate by Jefferies analyst Mike McCormack.

But in a note to clients Monday, McCormack questioned the “strategic value given long-term challenges of satellite video amid evolving consumer viewing habits.”

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